Commodity traders incorporate technical analysis into their trading plan. Technical analysis differs from fundamental analysis in the sense that it utilizes prior price action to predict future price moves. Fundamental analysis basically focuses on supply and demand expectations of commodities to predict future price action. Most commodity traders claim to either be a technical trader or a fundamental trader. In fact, most commodity traders utilize both methods. Mostly good traders trade off the charts but keep up on the fundamental picture to look for trades and to screen some marginal trades if they conflict with their charts.
To utilize technical analysis when trading commodities, you need to start by looking at a price chart of the commodity you are interested in trading. Following the trend is one of the golden rules of trading so you will want to look for a chart that is steadily moving higher or lower. Typically with technical trading, you will want to either buy an up-trending commodity when it is breaking out to new highs or it has corrected from the highs. This is a matter of preference to your individual trading style. Good traders normally like to buy retraced within a trend unless a market is extremely strong.
The good thing about technical analysis is that it applies to all charts, whether they are 5-minute charts for day trading futures or daily charts for longer term trading. The first thing you want to do is learn how to read charts and get a basic understanding of what types of patterns and indicators might setup market moves. From there, you can move on to more advanced commodity trading strategies with technical analysis. It is important to understand that technical analysis is not an exact science. It is more of an art. The same goes for fundamental analysis. Think of it as playing percentages. If you are right more often than you are wrong, You will come out ahead.
What Is Technical Analysis?
Technical analysis is a method of evaluating commodity prices by analyzing the statistics generated by market activity, such as past prices and volume. Technical analysts do not attempt to measure a security's intrinsic value, but instead use charts and other tools to identify patterns that can suggest future activity.
Just as there are many investment styles on the fundamental side, there are also many different types of technical traders. Some rely on chart patterns; others use technical indicators and oscillators, and most use some combination of the two. In any case, technical analysts' exclusive use of historical price and volume data is what separates them from their fundamental counterparts. Unlike fundamental analysts, technical analysts don't care whether a commodity is undervalued - the only thing that matters is a commodity’s past trading data and what information this data can provide about where the commodity price might move in the future.
The field of technical analysis is based on three assumptions:
1. The market discounts everything.
2. Price moves in trends.
3. History tends to repeat itself.
1. The Market Discounts Everything
A major criticism of technical analysis is that it only considers price movement, ignoring the fundamental factors of a commodity. However, technical analysis assumes that, at any given time, a commodity price reflects everything that has or could affect the value of the contract - including fundamental factors. Technical analysts believe that the commodity’s fundamentals, along with broader economic factors, weather patterns and market psychology, are all priced into the commodity, removing the need to actually consider these factors separately. This only leaves the analysis of price movement, which technical theory views as a product of the supply and demand for a particular commodity in the market.
2. Price Moves in Trends
In technical analysis, price movements are believed to follow trends. This means that after a trend has been established, the future price movement is more likely to be in the same direction as the trend than to be against it. Most technical trading strategies are based on this assumption.
3. History Tends To Repeat Itself
Another important idea in technical analysis is that history tends to repeat itself, mainly in terms of price movement. The repetitive nature of price movements is attributed to market psychology; in other words, market participants tend to provide a consistent reaction to similar market stimuli over time. Technical analysis uses chart patterns to analyze market movements and understand trends. Although many of these charts have been used for more than 100 years, they are still believed to be relevant because they illustrate patterns in price movements that often repeats itself.